Meg Green of the Miami Herald fielded a question about mutual fund performance from a 62-year-old retiree. His question is often asked by current investors, soon-to-be retirees and current retirees and those of who write about this topic always struggle with the answer.
Her answer kept to the basics but did little more than suggest an over-the-counter solution for an ongoing condition. That’s not her fault; it is an industry-wide problem that offers little in the way of a concrete method of determining how a fund is doing. In this case, the person asking owns a conservative investment portfolio, at least according to the query, and wants to know whether his return is acceptable.
The best line in Meg’s answer: “But little in investing is ‘pure’, or totally style specific.” You could look to Morningstar, she suggested with their in-depth rating system, which she points out is often the very system used by professional advisors. Or perhaps not because as she later explains, “last year’s five star could be this year’s dog.” This could be a the most worrisome problem for a retired person, who has begun to draw down the balance in the portfolio and is concerned that “out-of-favor” fund might be a long-term condition. (But for someone still contributing to the fund, this might be considered an opportunity to buy low.)
When a fund hits the 5-star rating offered by Morningstar, the fund’s coffers usually swell with new investors creating the possibility that the fund will close or the fund manager will simply have difficulty finding good investment opportunities. Which is why, in many instances they fall from those lofty rankings. Meg could have offered a longer range look backward at the fund considering how long it has been rated highly as some sort of guide. Steadiness over the long-term shows the investor that the fund is focused and its shareholders are believers.
She can be forgiven when she recommends that this person have their portfolio reviewed by a professional on a yearly basis (she is a certified planner herself). What she doesn’t recommend is that this person ask themselves what they would consider “good performance”. If the portfolio is being used based on a worst case scenario basis or is the outlook too rosy. In other words, is he drawing the fund down too fast to withstand a long stretch of poorly performing years?. If that is the case, he will be constantly chasing the trailing returns of funds that hit those high ratings. Meg is right when she says “you need to factor everything”.
Looking at performance from the recovery of the worst year the fund had might be a good indication of how well a fund might perform should such a string of bad years occur. The retiree has, based on many current estimates, a twenty (maybe even thirty) year draw down period.
You would hope that this person’s choice of funds, considered conservative, would already be tax efficient and be low in expenses. If not, that would be one of the single best moves he could make in the short-term. Each expense point saved is extremely important in this sort of instance.
Now just a brief thought about that draw down: Some suggest 4% is best by claiming you will never run out of money this way; some say 4% is too frugal in the early years when you might want to actually do something with your new found freedom and suggest 6-8% in the initial years and cutting back in the later ones; some others worry about the potential health care costs that might lurk in those later years. I would like to think you could wait as long as possible to make the initial draw by working some and in the process contributing some.
The bottom line is much simpler. Stocks (based on the S&P 500) have earned about 8% and that is over a very long period of time. So 4% might net this person some leeway. But this approach (using stocks in retirement) isn’t considered conservative by any means. How much does the person need to break even is the question he should ask of himself. And although Meg can’t answer his question with a question, she never mentions risk and his ability to take some as one the main prerequisites for any investment.
Read more of Meg’s response here:
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